The Skinny

Like all businesses, farming is subject to the prevailing market forces that dictate whether production is expanded or contracted based on input and labor costs as well as the existing market opportunities. While farm payments help some farmers navigate tough market conditions in the short-term, farm payments do not necessary effect the long-term viability of producers or the price of food.

True? Or Not? "Many U.S. farmers would not be able to make a living raising corn and other high-acreage field crops without government subsidies."

Bruce Babcock SAYS...

THE NITTY GRITTY:

The two most common arguments used in favor of farm subsidies are either that farmers would go out of business if they were eliminated and that farm subsidies are responsible for the fact that Americans spend less of their disposable income on food than any other country. These two arguments are effective because there is some historical truth to the first argument and the second argument seems to follow the first law of economics that we get more of what government subsidizes. But a close examination of how farm subsidies work and how farmers make production decisions reveals that their elimination would have little impact on food prices and that while farm subsidies can provide short-run help to farm finances, over time, the most efficient farmers will be making a living from agriculture with or without farm subsidies.

Market prices for farm commodities are determined by how much of a particular commodity is produced and the demand for the commodity. Production depends on how much land is planted to the crop and the weather during the growing season. The amount of land devoted to corn, soybeans, wheat, and other crops depends on the relative returns among them. If farmers expect to be able to make more money from corn than soybeans or wheat, then more corn will be planted. If wheat returns are expected to be high, then more wheat will be planted.

The importance of relative returns means that if farm subsidies were focused on a particular crop, and farmers needed to plant that crop to obtain payments, then more of the crop would be planted. Traditional subsidies are delivered directly to producers of the principle field crops (corn, soybeans, wheat, barley, cotton, rice, grain sorghum, oats and peanuts) through farm programs. All the major field crops that compete with each other for land are subsidized. Unsubsidized crops mainly consist of tree crops, other fruit, and vegetables which are not strong competitors for land with the subsidized commodities. Because subsidies increase the relative returns of all land-competing crops, not just a chosen few, the impact of farm subsidies on relative returns is generally minor. This means that the mix of the major crops grown is not significantly affected by farm subsidies.

But subsidies can increase the overall profitability of farming because they increase farm revenue. The most direct impact of higher profitability is that it increases the ability of farmers to buy or rent land, which, in turn, increases the price of land. Subsidy-induced increases in the price of land do not enhance farmers' ability to make a living. For farmers that do not own land, land price increases are just an increase in the cost of production. For farmers who own land, land price increases help their balance sheet, but they do not help cover production costs. Put more simply, higher land prices increase the returns to owning land but not the returns to farming.

A secondary impact of subsidies is that they can induce farmers to plant more crops by shifting land out of pasture or other grassland into crop production. Cropland expansion will result if farm subsidies are tied directly to production levels. That is, if farmers must produce a crop to receive a subsidy then they are likely to produce more crops.

But in 1996, traditional farm programs largely broke the link between production levels and farm payments by basing payments on what farmers produced in the past. The link is not completely broken because if prices get low enough, farmers enjoy the benefits of a floor price that protects all of their production. But these floor prices are so low that when market prices fall below these floor prices, high-cost farmers cut acreage rather than produce for the floor price.

Thus, both the total amount of land devoted to crop production and the mix of crops is largely unaffected by the existence of farm programs. This means that crop prices-hence food prices-would change little if all farm programs were eliminated. There simply is no truth to the argument that farm subsidies benefit consumers by lowering the price of food. Inexpensive food has resulted from improved seed varieties, better farm management practices and herbicides, more efficient food processing technologies and improved logistical networks, not farm subsidies.

A portion of farm payments run counter to market prices. When market prices fall below the floor price (the commodity loan rate), then farmers receive compensatory payments that make up the difference. Farm prices can fall dramatically, usually because of bumper crops or because of a sharp drop in export demand. Farmers who have made production and investment decisions based on the expectation of high prices can face financial trouble when market prices unexpectedly fall, particular when prices stay low for a number of years. For example, farm prices fell dramatically in the mid-1980s and from 1998 to 2001. The infusion of farm payments during these periods kept some farmers from having to declare bankruptcy and helped the balance sheet of all subsidized farmers. Thus there is some truth to the argument that some farmers have needed farm programs to stay in business.

A general characterization of farm programs is that when crop prices are high they deliver payments to farmers when the payments are not needed and when prices are low, they automatically provide a government bailout to a portion of producers who grow subsidized crops who otherwise would have to go out of business. But government bailouts are not permanent solutions. If GM does not produce high quality cars that consumers want to buy, it has no future despite its government bailout. Similarly, the discipline of the marketplace means that the most efficient farmers will be the farmers who make money from farming, with or without government help during tough times.

Thus, there is some truth to the statement that some farmers need farm payments to stay in business when prices are low and stay low, but over time, farm payments do not determine which farmers make a living from agriculture. The fact that farm programs have allowed some farmers to survive tough times does not mean that a significant amount of land would have remained idle had the programs not been in place. Land rents would have fallen and surviving farmers would have immediately expanded their own farm operations. Thus food prices and aggregate production are largely unaffected by the existence of farm programs.